Tom Blandford continues his series on selling a law firm. Here he focuses on valuing the firm and discusses the value placed on goodwill and work in progress:
How do we work out the value of the firm?
There is no one answer and in this area it is crucial to take professional advice.
The textbook answer is a multiple of either maintainable earnings (ie profit with suitable adjustments made to it) or a multiple of turnover or assets (being careful to distinguish between the book value of assets in the accounts and what they could actually be sold for).
In practice, the value is only as much as a willing buyer and a willing seller can agree on (usually late at night over multiple coffees!). Having a sensible mediator to run these conversations is key.
Do people still pay for goodwill when buying a law firm?
Yes they do. However, not in every case and it does vary considerably based on the attributes of the firm.
Even where they do not, there are still some areas to discuss. These might include realising work in progress and partners’ current/capital accounts that might otherwise go unpaid, finding a good home for clients and staff, and avoiding potential closure liabilities such as redundancy, onerous leases and run-off cover.
What value is placed on work in progress when the firm is sold?
More than you may think and so this is important.
Accountancy rules (known by its old name of UITF40 but actually Financial Reporting Standard 102, Section 23) dictate that the book value of WIP is likely to be very low, as you have to be virtually certain of its recovery. This immediately excludes many matters, especially those at an early stage or on conditional fee arrangements. However, in a sale negotiation there is no obligation to follow UITF40 – though the acquirer may wish to!
Instead, it seems fair that work properly done under your regime should be reflected in the consideration that you receive, the difficulty being in valuing those items. How complete is ‘nearly finished’? Will the court find in your client’s favour? Will the client pay? Will some of the recorded time have to be written off?
This area becomes very complicated very quickly. It is often the subject of days of careful due diligence and investigation by specialist accountants to come to a ‘fair’ representation of the WIP’s true worth. One number it is very unlikely to be is the figure in the financial statements!
What value is put on the tangible assets (eg the building)?
Probably very little. The second-hand value for desks, chairs, etc is effectively nothing.
If you own (and many firms rent) the building then clearly it has a market value (easily obtained from a surveyor), but that does not mean the acquirer wants the building. Many a former law firm building has found itself turned into luxury flats or a boutique hotel.
That said, acquirers are always keen to maintain a status quo. Many clients do not know the name of their solicitor, but they do know the address or the telephone number. The acquirer needs to harness that brand awareness – one mechanism to do that is keeping the same premises, at least in the short term.
How can we maximise the value of the firm?
The ultimate answer here is to be good at what you do and to be profitable. Clearly there are a number of ways to achieve that. Some are obviously financial (eg control overheads), but others are much less tangible (eg are your staff well motivated and trained?).
Whichever route you take (and there are several), maximising value in an exit scenario is not something you should leave until you step into the negotiating room. Have a five-year plan so that you can exit the firm on a high point – when potential acquirers can perceive the value they are getting, as well as what they can add to take it to the next level.